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Why is Dalal steet influenced by upcoming elections?

March 13, 2014 09:19 IST

Why is Dalal steet influenced by upcoming elections?

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Tulemino Antao

Several analysts are of the view that a pre-election rally in under way as the market is clearly building in positive sentiment.

As election fever grips the market, traders tend to look at various ways to benefit from the likely sharp swings in stocks. Among other strategies, a relatively safer way of making a quick buck from market gyrations is to bet on the volatility. 

Implied volatility (IV) remains high just before the polling starts and rises to a crescendo as soon as the exit polls start trickling in and the counting starts. “There are certainly expectations of a rise in implied volatility from the current levels to the run-up to the elections. One can position in different ways to capitalise on this expected rise in volatility,” says Siddarth Bhamre, head of equity derivatives and technicals at Angel Broking.

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Image: An investor gestures with folded hands towards the Bombay Stock Exchange (BSE) building while watching a large screen displaying India's benchmark share index in Mumbai.
Photographs: Arko Datta/Reuters

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IV is a measure of options traders’ expectations of near-term risks in the market. The recently-introduced India VIX futures can be used to hedge the risk of market volatility.  

Bhamre further says, “As IV’s now are quite low, one can go long in 3-weeks INDIAVIX futures and roll over three-four times to reach mid-May. However, the flip side to this is rollover cost and lack of liquidity in 3-weeks contract.”  

The other way is traditional formation of “long strangle” in April Nifty options. However, if there is no movement in underlying during this period, and even if implied volatility rises, delta and time value will work against this strategy, he adds. 

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Image: Investors prefer penny stocks when Sensex is down
Photographs: Uttam Ghosh/Reuters
Tags: VIX , Bhamre

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Why is Dalal steet influenced by upcoming elections?

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Volatility index and markets generally follow the inverse relationship - when VIX increases, the markets tend to weaken. Big traders can also use this future to hedge the option portfolio to limit the risk due to volatility.  

Nitin Murarka, head-derivatives, SMC Global Securities says, “As of now, we have only 3-weeks expiry future contracts for VIX futures; hence, we cannot buy May month VIX index. May month contracts will be introduced in April month. However, as per historical data, VIX generally rises during election months due to a lot of uncertainty. Currently, March VIX index futures is trading at 14-15 range. However, May options are trading at a VIX of 22 -24 per cent. "

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Image: Traders generally take risk in a volatile market
Photographs: Reuters

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He further says, "Hence, going forward, VIX is expected to go up from the current levels. Buying VIX index future would be good strategy just before election. Buying VIX index future will also give you hedge against long portfolio"  

In the previous general elections in April 2009, India VIX rose from 39.49 on April 1 to a high of 56.07 on May 20 as soon as the poll results ended.  

If you are able to buy VIX around 30 anytime from the last week of April until the election results, it will be a decent trade expecting volatility in the markets, says Nithin Kamath, Founder & CEO of discount brokerage Zerodha.

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Image: One can expect buoyancy in market at the onset of elections
Photographs: Arko Datta/Reuters
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In options, the ‘long strangle’, as it is called, would probably be the safest bet. It means buying Nifty OTM (out-of-the-money) calls and OTM puts. For example, if Nifty is around 6,300, buying the May 6,500 call and May 6,100 put. The premiums are pretty high right now. Also, it is best not to take any big bets for an uncertain event like this, he says.

Market experts are also of the view that the probability of Nifty hitting 7,000 is quite a possibility amid a favourable outcome from the elections.

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Image: Investors should play it safe and smart in a volatile market
Photographs: Reuters
Tags: Nifty OTM

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Murarka further says,“My sense is, Nifty can see a pre-election rally. Nifty can touch 6,600 levels before elections and there is a high probability of Nifty touching 6,900-7,000 levels after election results if we get a stable government. Nifty May expiry options are very costly as implied volatility is higher for May expiry. Going forward, buy on dip strategy should be followed. If there is any correction in Nifty, then I would recommend buying April 6,500 call option.”  


Image: According to market watchers, Nify may see a pre-election rally
Photographs: Dominic Xavier/Rediff
Tags: Murarka

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